China News

First, with deflationary forces still gripping the economy (year-over-year CPI has been negative by more than 1% since Feb), weakness in exports, Chinese officials are unlikely to allow the yuan to appreciate very much during the second half of the calendar year. The pricing of the non-deliverable forward implies expectation for less than 1% appreciation against the dollar over the next 12-months, the smallest expected gain in a couple of months. Next month will be the one year anniversary of the Chinese decision that in essence appears largely tantamount to re-pegging the yuan to the greenback. It has been confined to a little more than a 1% range since. Recall that under the fixed exchange rate regime of Bretton Woods, currencies were allowed to move in 1% bands. Last July the pricing of the 1-yr yuan NDF implied a 6% appreciation.

Second, the 63% rise in the Shanghai Composite Index has been among the world's top equity markets in H1 09. The story is often told is that the large fiscal stimulus efforts has ensured that the economy will gain new traction. Yet the stimulative measures are impacting perhaps in a way different from the conventional narrative. Part of the stimulative measures, included removing curbs on bank loans. Bank loans in China have surged by CNY5.8 trillion. The rating agency Fitch warned earlier today of the dangers of the massive rise in lending. Part of the lending--some reports suggest as much as 20% or some $170 bln--has found its way into the equity market.

Third, China and Hong Kong are expected to sign an accord shortly that will allow the settlement of bilateral trade to be conducted in yuan. Back in April the PBOC announced it would let Shanghai and 4 other cities in the Gungdong province to begin settled traded in yuan. China subsequently announced CNY650 bln (~$95 bln) in swap lines with a handful of countries, including Argentina, Belarus, Hong Kong, Malaysia and South Korea. Since Hong Kong is a special administration region for China that a greater share of its bilateral trade is settle in yuan is hardly earth-shattering, but there may be some interesting implications. Often Hong Kong is used by China and its trading partners to conceal trade as goods often get re-exported from HK. China and its trading partners often disagree on how such trade should be counted. More importantly, it takes more than diktat to determine an invoicing currency. As the SAFE (the State Administration of Foreign Exchange) made clear today, China recognizes that the US dollar will continue to dominate global trade. China's desire for the yuan to be more of an international currency and invoicing currency is not greater than its desire to maintain firm control of the currency. This is to say, China's ambitions are continue to hemmed in by the realities of a currency that is still not convertible.